Feb. 26 (Bloomberg) -- The U.S. may be saddled with more sluggish growth than the Federal Reserve expects as the economy struggles to shake off a lingering hangover from the housing bubble.

``We're in the midst of a classic boom-bust credit cycle in housing,'' says Andy Laperriere, managing director at International Strategy & Investment Group in Washington. ``And the bust is just beginning.''

The worst case: Distress already evident in the riskiest part of the mortgage-lending industry turns into a full-scale credit crunch that cripples the housing market and the economy.

More likely, say forecasters at ISI, UBS AG and Deutsche Bank AG, is an economy stuck at about a 2 percent growth rate in coming quarters, down from 3.4 percent in 2006, as housing demand remains in the doldrums.

That's below the Fed's forecast for 2007 and might prompt Chairman Ben S. Bernanke and his colleagues to dial back their concern about inflation and focus more on growth. At their last meeting, on Jan. 31, Fed policy makers discussed dropping their anti-inflation bias in favor of a more even-handed approach. In the end, they decided against a change ``at this time,'' according to minutes released on Feb. 21.

In testimony to Congress Feb. 14 and 15, Bernanke identified the depressed housing market as the biggest risk to the Fed's forecast for modest growth of 2 1/2 to 3 percent this year.

The Chairman's Concern

``The ultimate extent of the housing-market correction is difficult to forecast and may prove greater than we anticipate,'' he said.

Hopes for an early revival took a knock on Feb. 16 with news that housing starts plunged 14.3 percent in January to an annual pace of 1.408 million. That was the lowest level since 1997 and well below economists' forecasts of a 1.6 million rate. In response, St. Louis-based Macroeconomic Advisers LLC shaved its forecast of first-quarter growth to 2.8 percent from 3 percent.

``There's a high probability that we're going to get another tranche down in housing'' as banks and other lenders make it harder for buyers to take out mortgages, says Ivy Zelman, housing analyst for Credit Suisse Group in Cleveland.

The financial fallout from the housing slump delivers a one- two punch to the industry and the economy.

Foreclosures Jump

It increases supply as homeowners with adjustable-rate mortgages can't meet the higher loan payments and are forced out of their houses. Mortgage foreclosures monitored by Irvine, California-based research firm RealtyTrac jumped 19 percent in January.

The credit squeeze also depresses demand as prospective buyers find it more difficult to obtain loans. According to a Fed survey published on Feb. 5, more U.S. banks toughened lending requirements for home loans in the final three months of 2006 than in any quarter since the early 1990s.

``There's more tightening of lending standards to come,'' says James O'Sullivan, an economist with UBS in New York. ``That will hold down sales.'' UBS sees the economy expanding at an annual rate of just below 2 percent in the first and second quarters of this year before picking up to 2.3 percent in the third.

This contrasts with a consensus forecast of 2.5 percent growth in the first half, rising to 2.9 percent in the third quarter, according to a Bloomberg News survey of 71 economists taken Feb. 1 through Feb. 8.

Riskiest Borrowers

The financial stresses are most evident in the subprime mortgage market for the riskiest borrowers. The segment accounts for 13 percent of the $10 trillion in home loans outstanding, according to Inside Mortgage Finance, a trade publication.

Some 20 percent of the roughly $1.2 trillion in subprime loans made during the past two years will end in foreclosure, with owners losing their homes, says the Center for Responsible Lending in a study. The center, located in Durham, North Carolina, is a nonprofit organization financed by the Ford Foundation and Rockefeller Foundations, among others.

More than 20 subprime lenders have closed in the past three months, according to Inside Mortgage Finance. The lenders that remain are tightening credit standards and throttling back on loans. New Century Financial Corp., the second-largest home lender to the riskiest borrowers, said on Feb. 7 that it expects its loan volume to drop 20 percent this year.

Delinquencies Rise

The strains, though, aren't isolated in the subprime market. Delinquencies on adjustable-rate loans to prime borrowers rose to a three-year high of 3.1 percent in the third quarter of 2006 from 2.3 percent a year earlier, according to the Mortgage Bankers Association. Lenders are slated to reset as much as $1.5 trillion in ARMs this year.

What's particularly troubling is that many borrowers are having problems making payments at a time when the job market is strong and the unemployment rate is near a six-year low, says Nouriel Roubini, chairman of Roubini Global Economics and professor of economics at New York University.

Behind the rising delinquencies: lax lending standards over the past few years that allowed buyers to take out loans with low initial rates, only to find they couldn't afford higher monthly payments when the rates adjusted. Now, some of these borrowers can't refinance because they owe more than their homes are worth. Home prices declined in the fourth quarter in half of U.S. cities monitored by the National Association of Realtors.

Eager Buyers

The drive to easier lending standards was fueled by demand from investors for higher returns. With yields on 10-year Treasury notes more than a percentage point below the 5.9 percent peak reached in 2000 during the last economic expansion, investors have been eager buyers of higher-yielding securities backed by mortgages.

Further fueling the market was the rapid growth of collateralized debt obligations comprising the risky forms of mortgage-backed debt. Now, demand for these securities is ebbing as rising delinquencies frighten off investors. The perceived risk of owning low-rated subprime mortgage bonds rose to a record last week, according to an index of credit-default swaps.

``This a taste of what could happen,'' says Joshua Rosner, managing director of research firm Graham Fisher & Co. and co- author with Drexel University Associate Professor Joseph Mason of a paper on mortgage-backed securities. ``The housing market could take another leg down as the credit cycle turns.''